Power Dynamics of Governance

Governance, at its core, is a framework designed to ensure accountability.

However, accountability is not a concept that exists in a vacuum; it is intrinsically linked to power dynamics, so one is only truly accountable to someone else if there's a power dynamic at play. This interplay of power forms the beating heart of corporate governance, particularly in the high-stakes world of financial services.

This article contains my thoughts and notes as I examine governance from a first-principle perspective, peeling back the layers of corporate accountability and examining the power dynamics that shape decision-making at the highest levels.

The Essence of Governance

At its most fundamental level, corporate governance is a system of rules, practices, and processes that dictate how a company is directed and controlled. It's the architecture that defines how power is distributed and exercised within an organization. Therefore, for accountability to be meaningful, there must be a disparity in power between the party being held accountable and the party doing the holding.

Consider a simple example: a board of directors can hold a CEO accountable because they have the power to hire, fire, and set compensation. Conversely, while a CEO might be responsive to employee concerns, they're not truly accountable to individual employees in the same way due to the different power dynamics.

In practice, this principle extends throughout the corporate structure, translating to a complex network of relationships between a company's management, its board, its shareholders, and other stakeholders. Each of these entities holds a degree of power, and it's the interaction between these power centres that forms the essence of governance.

Financial Services Power Players

Financial institutions wield enormous power through their control over capital flow and allocation, affecting individuals, businesses, and entire economies. This power necessitates robust accountability mechanisms, leading to a complex governance landscape.

Here are the key power players influencing corporate governance and who they report to in the context of financial services vertical:

• Regulators: A top player, regulators grant or revoke permission to operate in their market. They set the rules, enforce compliance, and impose penalties for breaches. Their authority is non-negotiable, so companies must align with regulatory requirements or risk losing their right to operate. [Report to: ---]
• Shareholders: Key influencers, particularly institutional investors, who wield power through ownership stakes and voting rights. They shape corporate strategy by electing board members and engaging with management, with their influence varying by the size of their holdings and level of activism. [Report to: ---]
• Board / Non-Executive Directors (NEDs): NEDs provide independent oversight, challenging executive decisions and safeguarding shareholder interests. Their power lies in their ability to influence board decisions, though it depends on their independence, experience, and respect within the boardroom. [Report to: Regulators & Shareholders]
• Executive Team: The operational leaders of the company, responsible for executing the board’s strategy and managing day-to-day activities. Their power comes from their control over resources and decision-making processes, but they are held accountable by the board and shareholders. [Report to: Board, Regulators, Shareholders & NEDs]

Other indirect power players that could influence governance oversight are:

• Rating Agencies: External assessors that influence a company's financial standing by evaluating creditworthiness. Their ratings can affect a company’s ability to raise capital and sway investor confidence, making their influence critical despite not being involved in daily operations.
• Media: Public watchdogs that shape corporate reputation through reporting and analysis. Their influence stems from their ability to impact public perception, stock prices, and even regulatory attention, making them a powerful, albeit indirect, player in corporate governance.

The Internal Governance Microcosm

While external power players define the broader governance landscape with clear and established authority, the power dynamics within the executive layer are more fluid and regularly shift. This fluidity creates a complex microcosm where individuals and groups, driven primarily by motivations, compete for influence, resources, and control.

To explore the ever-evolving power dynamics of internal governance, we must consider the motivations shaping behaviour, decision-making, and, ultimately, the governance of the organization.

I am no psychologist, but I think of motivation through the following four areas:

• Resources: The pursuit of financial and material gains. This could extend beyond personal compensation to include control over budgets, allocation of company resources, and influence over investment decisions.
• Sex: While often unspoken in professional contexts, the desire for status, attractiveness, and dominance can subtly influence behaviour and decision-making.
• Companionship: The need for social connection and belonging drives individuals to form alliances, create in-groups, and sometimes engage in exclusionary practices. This can lead to the formation of informal power structures within the formal corporate hierarchy.
• Power: Perhaps the most direct driver in governance contexts, the desire for control and influence shapes much of the internal dynamic. This includes both formal power (titles, positions) and informal power (influence, respect from peers).

View From the Second Line

The interplay of these motivations shapes a complex web of alliances, conflicts, and negotiations within the corporate structure. Understanding these internal dynamics is essential for evaluating the true effectiveness of governance.

When assessing a governance framework, a series of boxes with lines showing information flow on a PowerPoint is not enough. As part of the second line, we should attempt to understand the motivations at play. This approach allows us to:

• Identify potential conflicts of interest arising from personal motivations.
• Steer the design of incentive structures that align individual motivations with corporate goals.
• Recognize and address informal power structures that may influence decision-making.
• Foster a culture that channels these motivations productively rather than destructively.

This holistic approach not only strengthens governance but also fosters a corporate culture where individual motivations are harnessed constructively, ensuring that personal interests align with the broader goals of the organization.

Case Study: Regulatory Oversight in Cross-Border Governance

As an ex-regulator, I've witnessed firsthand the complexities of power dynamics in cross-border governance. A particularly illustrative case involved the decision to exclude US group representatives from UK operation's Board. The rationale behind this decision was to prevent the parent company from overriding local practices, which could potentially undermine the interests of UK policyholders/customers.

However, the reality was far more nuanced. Excluding the group representatives from the board didn’t necessarily eliminate their influence. With its vast resources and overarching control, the group could still exert significant power over the subsidiary’s decision-making through informal channels and strategic pressure. It’s na?ve to think that simply keeping a group representative off the board would prevent them from influencing key decisions.

A more effective approach could have been to allow group representation on the board but to implement robust key performance indicators (KPIs) and other monitoring mechanisms to ensure that the local subsidiary’s practices aligned with regulatory expectations. This would have empowered the local regulated roles while still maintaining the necessary oversight.

By focusing on transparency and accountability rather than outright exclusion, we could have created a governance structure that recognized the realities of power dynamics while safeguarding the interests of all stakeholders.

Concluding Thoughts: Beyond the Boxes and Arrows

Understanding the formal structures is not enough; effective governance requires a thorough understanding of the motivations, relationships, and informal power structures that shape decision-making at the highest levels.

For risk teams, this means going beyond the surface to really get to know the business teams and the executives they support. By understanding the motivations and dynamics at play, risk teams can identify potential conflicts of interest, help design better-aligned incentive structures, and address the informal power structures that influence decision-making.

However, risk teams often find themselves time-poor to engage in this deep, meaningful work because they are bogged down by routine tasks like gathering and reporting information. This is where CoVi Analytics comes in - our first principle approach is designed to reduce these overheads for both the business (first-line) and risk teams (second-line), streamlining the routine so that risk professionals can focus on what truly matters.

By automating and simplifying the administrative burden, CoVi frees up risk teams to dive deeper into understanding the complex dynamics of the business, allowing them to build governance frameworks that are not only robust but also responsive to the rich tapestry of power relations that define the essence of corporate governance in practice.